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ON HALLOWEEN, THE FEDERAL Reserve decided that the risks to the economy were evenly balanced between slowdown and inflation. Just over a week later, Fed Chairman Ben Bernanke said that risks of slower growth had increased from the credit-market turmoil and soaring oil prices.

"Incoming information on the performance of mortgage-related assets has intensified investors' concerns about credit-market developments and the implications of the downturn in the housing market for economic growth," Bernanke said in his prepared testimony to the Joint Economic Committee of Congress Thursday.

That's putting it mildly. Odds of another 25-basis-point (quarter-percentage point) cut by the Federal Open Market Committee on Dec. 11 jumped to 100% after unrelenting bad news in the credit markets, including the first liquidation of a collateralized debt obligation, massive write-downs and rumors of more. After the FOMC meeting that ended Oct. 31 with a 25-basis-point cut in the panel's fed funds target, to 4.50%, the futures market had the probability at just 50%.

Short-term Treasury yields plunged in a renewed flight to quality, sending the three-month bill's yield down 35 basis points to 3.26%, the lowest level since last July's panic. The two-year note, a key barometer of rate expectations, saw its yield plummet 27 basis points, to 3.417%, the lowest since February 2005. The benchmark 10-year note yield fell a more moderate 11-basis points, to 4.211%, the lowest since September 2005.

Standard & Poor's said that a $1.5 billion CDO called Carina CDO Ltd. managed by State Street Global Advisors had started liquidating its assets. As a result, S&P slashed the ratings on Carina's top tranches all the way from triple-A to junk double-B in one fell swoop. Subordinate tranches were cut as low as double-C.

Some 13 other CDOs have told S&P of default, a precursor of liquidation. The CDOs' problems also reflect the ongoing contraction in the market for asset-backed commercial paper, a prime source of funding for SIVs (structured investment vehicles), which hold CDOs and other manner of alphabet soup.

And it's only likely to get worse. In a report strikingly titled, "Staring into the Abyss," RBC Capital Markets interest-rate strategist T.J. Marta says that additional write downs are coming, owing to a new FASB accounting rule, 157, that will force more financial companies to put prices on "Level 3 assets." These assets have no active market, so they've been "marked to model," based on their credit ratings, which are now turning out to have been faulty. FASB 157 is to take effect Thursday, Nov. 15.

Marta says RBC's equity-strategy team says the U.S. banking sector is "embarking on its third major crisis since the 1920s." He adds: "Not only have the 'go-go' days of structured products come to an inglorious end -- at least temporarily -- but vast swaths of the financial system lie in ruins,"

"Perhaps the most damaging aspect is the broken trust," Marta continues. One of reasons U.S. financial markets were a magnet for the world's capital was their reputation for transparency and trustworthiness.

"Now traders and investors complain that securities like CDOs have declined in value, but also no defensible value can be readily assigned. The U.S. dollar's collapse in these circumstances is not surprising," he concludes.

Credit and Currencies Drive Rates: Massive bank write-downs and the dollar's continued slide battered the credit and equity markets, but set off a renewed flight to quality, sending yields on short- and intermediate-term Treasury securities sharply lower.